New crowdfunding law offers hope, not magic

In 2011, Georgia adopted a rule that allows everyday residents to invest in companies through crowdfunding, but instead of receiving a T-shirt or a watch made by the startup, they get an ownership stake — a measure similar to legislation being enacted in Tennessee next month.

Viewing this as a pivotal change that could support Georgia's small businesses, Atlanta lawyers Megan Johnson and Jeff Bekiares launched an online equity crowdfunding portal, SparkMarket, that would sell stock in a company to residents and facilitate investments for Georgia startups hungry for dollars.

Three years later Johnson is candid in her assessment that it has not yielded explosive fundraising; in fact, far from it. Her takeaway for Tennessee startups and small businesses eager to see results from the new law is this: Raising money is still going to be very difficult.

"It has been kind of slow-going in terms of getting awareness about it and figuring out how to help folks use it," said Johnson. "There is a lot of investor education that has to happen for this to be successful."

The "Invest Tennessee Exemption" was signed into law in May, touted as a boost to small businesses and startups by providing more funding options. But given the tepid response in states that have already implemented the exemption, it is unlikely that the new law will have a meaningful impact in the short term. The law has potential to help Tennessee companies, and it is certainly a step in the right direction, but much of its overall success will depend on helping businesses and investors navigate the legal complexities and making them aware of its potential benefits.

Under current law, companies seeking private investment are limited to capital provided by accredited investors — those who meet six-digit income thresholds or with more than $1 million in assets, not including their home. The rule is meant to protect less wealthy individuals from losing money in risky investments, but it poses a challenge for companies lacking a network of affluent investors, in addition to shutting out everyday people from startup investment opportunities. While non-accredited investors can donate to a Kickstarter campaign, they are not able to make financial gains when a company is successful.

That changes Jan. 1, as Tennessee joins at least 11 other states with similar crowdfunding exemptions. Tennessee companies will be allowed to raise as much as $1 million from in-state investors and investors can contribute as much as $10,000 to capital raises.

Nashville securities attorney Bob Zeglarski has begun educating local entrepreneurs about the law, describing it as a more affordable funding option for small businesses, but his expectations for how many companies will pursue this route are tempered. "It's just the starting point of an opportunity, but an opportunity, nonetheless," he said.

Startups that pursue this funding route need to be careful about liability risk, he said, and they could also see drawbacks in having to answer to a large group of investors. There is also the risk to the investors that the business flops.

Closing first mile of capital

Since launching in 2012, Johnson's SparkMarket has listed three companies seeking capital on its portal with one company, an oilcan guitar maker named Bohemian Guitars, surpassing its funding goal with more than $130,000 raised. What aided Bohemian's success was all the legwork its founders did on the front end to build awareness of the fundraising platform, Johnson said.

A second company, a coworking space and business incubator called Opportunity Hub, has raised close to $15,000 with about $35,000 more scommitted, working toward its goal of $600,000. Founder Rodney Sampson, an Atlanta tech entrepreneur and angel investor, said he was intentionally aggressive with his goal, wanting to set a precedent for using this type of funding that he sees as very important in helping businesses tap into support from local communities. He is optimistic about its potential as the state's investors and entrepreneurs gain experience with the exemption.

"Crowdfunding has the potential to close that first mile of capital that's required to get a startup or early stage company the traction they need," Sampson said. "With anything that's new, it takes time for traction."

SparkMarket has since shifted its focus to providing legal services for those exploring equity crowdfunding — creating deal documents and establishing best practices — and has advised several other states making changes to their own investment laws. It is also developing technology tools that will help businesses run crowdfunding transactions of their own without going through a portal.

Despite all the headwinds, the exemption is a positive step for companies and the state, as it has raised interest in launching a company in Georgia. GroundFloor, for example, is a real estate crowdfunding company that moved to Georgia from North Carolina because of the investing option, Johnson said.

Opportunity in accredited investors

Perhaps most telling of the new exemption's limitations is the direction of Phil Shmerling's Nashville startup, InCrowd Capital. Shmerling began building his company two years ago, originally envisioning it as a platform for equity crowdfunding for startups and non-millionaire investors that would be possible under the federal Jumpstart Out Business Startups (JOBS) Act.

With no state exemption in the works and a slow rollout of the JOBS Act, he changed his focus to connecting startups with accredited investors, which he sees as a more promising business model. Now that Tennessee is enacting its own exemption, Shmerling may pursue his inital concept at some point, but more as a social enterprise.

"It's not a product I plan to make money on," he said.

In some cases, using the exemption could actually hinder equity raises as many early stage companies garner out-of-state investments in their capital raises, which is not possible with under the new exemption, says Nashville attorney Chris Sloan. Additionally, it could interfere with subsequent capital raises as some bigger investors may view a startup with a large number of early stage investors as being more susceptible to a lawsuit.

So while the exemption will not be a panacea to the state's startup funding needs, it could be a starting point for more investors to support their community's small businesses that are less likely to seek additional, larger rounds of capital. In Kansas, the first state to implement the equity crowdfunding exemption, it is those types of small businesses that have sought this type of funding. A general store, a grocery, a brew pub, a dairy and a digital television station were among the first eight companies to have filed for the exemption since it was adopted in 2011.

"It's really the community gathering around a perceived need and providing the funding for it," said Lynne Hammes, finance director for the Kansas Securities Commissioner Office, adding that challenges remain. "It's pretty easy, honestly, to get an offering ready to go to sell. The hard part really is trying to sell it."